Mar 20, 2015

Regional Comprehensive Economic Partnership (RCEP) is a Free Trade Agreement between ASEAN countries plus three (China, Japan, South Korea) and three more (India, Australia, New Zealand). The contours of this FTA is under discussion and negotiations are on. More at wikilink.

India is already into trade agreements with most of the participating countries in RCEP. The traditional discourse in the media focuses on how our 'Look East Policy' needs this FTA. Also, RCEP is supposed to work as a common framework which will remove some of the confusion that arises out of multiple FTAs in this region with India, each having its own scope, its own rules of origins and such. In addition, we are not part of the other two big trade negotiations, viz., the trans-atlantic and trans-pacific agreements, currently underway.

There are some points that I thought the greater debate in Indian media (if ever there was one on such topics) is missing, and which can be discussed in a post like this.

China, the biggest partner at RCEP, is a country where the wages have shot up. The wages have risen by around 12% per annum since 2001. This has created challenges in sustaining low cost manufacturing model of China. Of course, Chinese productivity too has soared in tandem, but that's no solace to industries that are labor intensive, such as garments, shoes, assembly lines of electronic goods and so on; basically those functions that cannot be easily automated. Some firms have moved interiors, away from coast, in search of lower wages and some have fanned out, into ASEAN. The so called 'Factory Asia' concept, that encompasses complex web of FTAs between China, Japan and ASEAN and covers major portion of world value chain, is deepening. The wage differential is significant between countries like Vietnam, Indonesia, Philippines and China. For example, the wages in Vietnam is around one fourth of that in China. Naturally, labour intensive Chinese firms are relocating to these countries. India is not a beneficiary. We are not yet locked into the production value chains to the extent that we should have been. We need to understand the reasons for this.

Factory Asia concept succeeded because these countries have low tariff duties between themselves, thanks to the multiple FTAs between them. Also, these countries are geographically closer, and use proximate and efficient ports such as Hong Kong, Singapore, Busan, Shanghai etc. In addition, the management can easily move across locations due to geographical proximity, leading to closer control and higher confidence about the quality. Another factor that is strengthening Factory Asia is the increase in purchasing power of China, and a conscious move towards consumption led growth model in China, which has gathered pace. The production of goods closer home cuts down the transportation cost and time. In short, a low tariff barrier (through SEZs and FTAs), combined with proximity and efficient infrastructure has done the trick. With the fall in transportation costs due to containerization, the geographical proximity is the one that matters least.

India, unfortunately is geographically away from this hub (relatively speaking) and suffers from inefficient port infrastructure, adding to time delays, thus further alienating us away from Factory Asia. Of course, the sectors in which we still manage to thrive, such as Garments and Leather, Gem and Jewellery, etc, are the ones in which transportation costs are low and not much discretization is needed in terms of stages of manufacturing. Contrast this with electronic gadgets where such discretization is prevalent, and India vanishes off the map.

Now coming to our approach towards FTAs, we have seen that India tries to ensure that our domestics are protected behind tariff walls, while we try to penetrate others' market. That approach, alas, has flopped. Most of the FTAs India has signed show abysmally low usage and effect. There has hardly been any impact of these FTAs on India's trade growth. We might as well write them off as useless. At least, if the FTAs had integrated us to the value chains it would have yet made some sense, but even on that count positive data is elusive.

Now, coming to RCEP, we are again looking at the same approach (from what I could make out from the discussions around, correct me if I am wrong). We would go with our conservative positive list, try to ensure we concede minimum, while maximizing our gains at RCEP. Frankly, this is the exact approach that would kill RCEP.

The actual trade in the successful Factory Asia model happens between duty free zones; components shuttle from one SEZ to another in China and neighbors till the final product is made and shipped. Anything hidden behind tariff wall is simply a no-no into the production chain, as it would add to costs and time delays in clearances and documentation. It is indeed sad that Indian policymakers are thinking in terms of tariff lines and protectionist measures. We have nothing to show that this approach works. We are not part of major value chains, nor are we growing significantly in terms of world share in goods production. Our approach in the WTO last year, where we blocked the trade facilitation agreement, reeked of this conservative mentality. We are yet again following the same approach, at the behest of some vested interests who want the tariff walls to remain forever They might be vociferous, but they have dim understanding of policy-making and economics. Such elements are best ignored as long as they don't come up with hard data to support their stand.

In addition, one has to understand that the world has moved beyond the stage of cheap wage model. The Chinafication is complete and has stabilized around the south China seas. If we indeed want to be a part of the goods producers network, like our slogan make-in-India declares, we need to start seriously looking at ways to integrate ourselves into the production chains. We are located where we are and can't change that. If major shipping lines do not pass through our ports, it has more to do with our bad port infrastructure than our location. It is sad that Colombo is preferred transshipment destination over Chennai due to congestion issues. A high tariff barrier, and time consuming documentation only adds to the woes. We can sit here with cheap and low productive labour forever and wait for Chinese wages to go up, or look at what has gone wrong in our model and reboot it. To start, let us acknowledge that we need RCEP more than RCEP needs us.

PS: I have ignored the services sector in this post, to be covered separately in another post.